History 101: Price controls don't work

June 07, 2007|By Jack Rafuse

For decades, the price and availability of gas has generated political heat. As a former Nixon administration official, I've been there and seen that. But what is surprising is the unwillingness of some in today's Congress to learn from our mistakes. Bills in the Senate and House today want to impose price controls on gasoline.

For those with memories shorter than mine, President Richard M. Nixon imposed wage and price controls on Aug. 15, 1971. Oil and gas were two of many commodities affected. An initial 90-day freeze turned into more than 1,000 days before the controls were dismantled. Inflation -- just above 4 percent in 1971 -- was in double digits when the controls were lifted.

Nixon kept the wage-and-price controls on oil, gasoline and petroleum products in place, as did Presidents Gerald Ford and Jimmy Carter. The results were disastrous. Oil exploration and domestic oil production slowed sharply. And foreign oil poured into the nation's gas tanks, filling the booming demand for price-controlled gas.

Thanks to this misguided policy, gasoline lines snaked along highways for hours during oil crises in the mid- and late-1970s. Stations ran out of gasoline and laws told consumers which days they could purchase gas. A windfall-profits tax compounded all the negative effects, and the shortages lasted until President Ronald Reagan repealed controls in 1981. The price of a gallon of gas at the pump fell by a third over five years.

With this kind of record, you might wonder what Congress is doing considering price controls and windfall profits taxes on gasoline. The Federal Trade Commission has repeatedly cautioned against reverting to this failed policy, warning: "If natural price signals are distorted by price controls, consumers ultimately might be worse off, as gasoline shortages could result." Artificial price caps ignore market forces and result in shortages during times of increased demand. Take the controls off to alleviate the shortages and prices rise higher than when controls went on.

A quarter century after the failed policy was repealed, the biggest determinant of prices at the pump is global and local supply and demand; crude oil and petroleum are internationally traded products. Then there's government. On average, state and federal taxes account for about 46 cents on the gallon. Typically, refining, marketing and transportation account for more than a quarter of the price.

The market price of oil and gas cannot be "controlled" by governments, corporations or consumers. Following Hurricanes Katrina and Rita, the Gulf region's energy infrastructure was badly damaged. At the height of the U.S. drilling season in 2005, Katrina shut down platforms that produced one-sixth of America's domestic oil supplies. Ports that are conduits for almost a third of U.S. oil imports and refineries that process almost a third of the nation's oil supply were down. As a result, gasoline prices then hit $3.05, up $1.20 from 12 months earlier.

After Katrina, while the market encouraged everyone to cut back, there were no 1970s-style gas lines or closed stations elsewhere in the nation.

Other producers -- domestic and international -- were motivated by higher prices to take up the slack. In fact, oil exploration drilling is at a 20-year high and expenditures are at an all-time high. That's how markets work.

A Federal Trade Commission study, following Hurricanes Katrina and Rita, confirmed that common-sense conclusion. The FTC concluded that the market worked well -- without evidence of price gouging or illegal market manipulation -- and that price controls would have made the situation worse.

The history lesson for this Congress could not be clearer. Price controls could create shortages and leave our economy dangerously exposed to disruptions in supply. In the 1970s, we were the only nation on Earth to have gas lines. Why would anyone ever want to go back to that?

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Jack Rafuse is a former energy adviser to the Nixon administration and currently heads Rafuse Consulting, which represents a variety of clients, including energy companies. He also is an independent consultant on energy and trade issues.